An athlete who wants to enjoy risky sports has to follow safety rules; in like manner, any individual who wants to produce superior investment returns has to follow foundational principles and benchmarks that have been used by several successful investors and has proved to work most of the time in both bull and bear markets.
Our job as professional investors is to do a superior job, and our superiority comes from producing good returns earned with the risks under control.
In the final analysis, nobody can provide a set of rules that works all the time. The key is to have a way of thinking that works all the time. In this article, I have outlined some key principles that can help shape the thinking of investors and also serve as guiding principles for anyone looking to have a career in investing.
I must say, that some of the principles outlined in this article are pretty advanced and goes contrary to mainstream knowledge and opinions about investing which you might have already gotten to know. This write up has been particularly designed for individuals and institutions who are in the business of investing for a living or considering to do so and may therefore not be suitable for everyone.
In proceeding further, here is what I consider tenets of successful investing;
v The Identity Principle;
Just like every other profession; professional Doctors, Teachers, Lawyers and so forth, the field of investing is a professional field and must be seriously considered as such.
Very often you will find people take an introspective look at themselves, strip away all their illusions and make careful thoughts and considerations before venturing into any professional field of endeavor from which they expect to make ends meet. Same goes with investing!
The identity principle therefore simply states; know thyself. Thus, the first step to succeeding in the field of investing is to take an unbiased introspective look at your personality, values and beliefs in the first place, to consider whether this is something that aligns with your purpose in life and you really want to bet your life on. If the answer to this exercise comes out as a clear “NO” then your journey probably ends here and the rest of this article may not be suitable for you.
A good advice for you is to hand over your investment funds to a professional money manager or fund manager to invest them on your behalf and charge you some billable fees!
It is essential that anyone looking to produce superior returns from investing that outperforms market averages must first be in sync with their own personality. Essentially, investing is an art that employs human judgments, perceptions and expectations in making investment decisions from time to time.
As a field that requires the use of so much individual judgment and perception, investors are always battling with the demons of judgment bias and perception bias. Judgment and perception bias is the human tendency to subjectively err about events. Leading us to make bias interpretations and conclusions which are likely to deviate from reality. It is the tendency we have to create our own reality other than what actually prevails.
A person aspiring to reach the level of professional investing must take to the habit of deliberately and consistently monitoring their thoughts, and carefully examining their thought patterns to identify how their own personality and mental makeup can distort their goal of wanting to think objectively when making investment decisions and always counter non-objective thoughts with objective ones. I can’t describe enough how hard doing this can be.
Additionally, when we talk about the identity principle, it also has to do with the time horizon of investing that is in sync with a person’s personality and way of life. Thus, being able to establish as to whether you are more predisposed to short term investing, medium term or long term. This is key in helping to choose the assets and investment modules that will best suit you. Studies have revealed that individuals who are very much action oriented, who love fast cars, fast motors and often find themselves in lots of action in life are more predisposed to high frequency, short term investment modules with high risks and high returns, whiles individuals that are more reserved, cool, calm and collected and don’t engage themselves much in high adrenaline activities are much more suited for long term investment modules, since such folks will want to deeply understand the nature of whatever it is that they are investing in.
v The Risk Principle;
The risk principle of investing may sound like a cliché. It makes us understand that, all else being equal, high yielding investments ventures embeds in them potentially high risks of loss whiles low yielding investments carry relatively less risks of loss.
I stated earlier in my opening paragraph that the job of a professional investor is to do a superior job which has to do with producing good returns (that outperforms market averages) earned with the risks under control.
Essentially, one of the key difference between a professional investor and all others, is that, they are able to effectively manage and control risk while producing good returns. Effectively controlling and managing risks entails a number of factors;
- The first amongst them is to openly and genuinely know and accept the risk of potential loss in the first place.
There is always the tendency for investors to erroneously underestimate risk in many instances. Miscalculating risk can be very costly in the field of investing and professionals should not be fond of this. As such, knowing the risk implies that all considerable effort has been put in place to ensure that the appropriate degree of risk of loss is carefully ascertained and catered for. Additionally, the next step after knowing the risk is to genuinely and wholeheartedly accept it. Risk that has not been genuinely and wholeheartedly accepted cannot be effectively managed and controlled in the first place. To properly communicate what it means to wholeheartedly accept the risk of loss may sound somehow like this; assuming that you are wrong, the moment after making your investment decision. It also means that you are able to sleep well, even when your investment is going bad.
In general, assuming that you are wrong helps to minimize the psychological pain the average investor experiences whenever they lose their investments.
- Prepare for the downside; if you can properly contain the downside of loss, you can control risk effectively.
v The Price Principle;
In investing, price is the leading indicator of all market variables. Whether your area of specialization is real estate, precious metals, commodities, natural gas, currencies or stocks, you would have to interact with price every time. Essentially because many high yielding assets tend to experience relatively higher price volatility. In view of this, being able to accurately tell the general directional bias of the market you are involved in from time to time is key to your long term survival.
Price is King
At the very fundamental level, the winners in every market are those who are able to accurately pick the right market direction in both bull and bear markets and also have the appropriate psychological resources to make timely decisions without wasting time on regrets and wishful thinking. To survive long term one must be able to change their perceived market directional bias immediately markets change; as price seem to say to investors; “follow me and I will show you the way to riches”.
Legendary investor, Paul Tudor Jones put it out very well, he said, “Your job is to buy what goes up and to sell what goes down. The whole world is simply nothing more than a flow chart for capital”. Sometimes the challenge is that some investors are able long in bull markets but for some reasons are unable to sell short in bear markets. In forecasting the financial markets, price is the leader of the market crowd.
Author: E.O Essien
E.O. Essien is a Chartered Economist with accreditation from the Global Academy of Finance and Management (GAFM) and the Association of Certified Chartered Economist (ACCE). He is a professional currency speculator, economic columnist and an Investment Analyst. You may reach him via email on firstname.lastname@example.org or on 0203656160, he will be glad to hear from you.